TAX INCREMENT FINANCING FOR PAKISTAN

Salman Ahmed Shaikh

salmanashaikh@iba.edu.pk PhD Scholar & Economics Faculty IBA Karachi

Presentation Outline

Introduction Mathematical Model Possible Hindrances in TIF Application in Pakistan Pre-Requisites for TIF in Pakistan Welfare Benefits of TIF in Pakistan

Introduction

Housing Needs: 8 Million (Source: World Bank). Urban Population Growth > Total Population Growth

Reason: Urban Centric Development

Result: Increased Cost of Living

House Rent Inflation

House Rent Inflation
18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00%

2.00%
0.00% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 House Rent Inflation Linear (House Rent Inflation)

Source: Economic Survey of Pakistan 2012-13

Introduction

Need: Develop New Cities Reason: Developing Cities Have Positive Externalities

Who Must Initiate? Cities Are Public Goods

Problem: Funding Development Expenditure Solution: One of the Many, TIF.

Basic Idea of TIF

When a public project such as a road, school, or hazardous waste cleanup is carried out, there is often an increase in the value of surrounding real estate and new investment. This increased site value and investment sometimes generates increased tax revenues. The increased tax revenues are the "tax increment". TIF dedicates tax increments within a certain defined district to finance debt issued to pay for the project. TIF is a tool to use future gains in taxes to finance current improvements which will create the conditions for those future gains. This tool is widely used in U.S and in Europe.

Basic Idea of TIF

Mathematical Model

Tax on property () function is based on two components, i.e. tax rate on property ( ) and taxable base value of property ( ). = --(1)

The taxable base value ( ) can be decomposed into its own components, i.e. number of properties in a locality ( ) times market value of each property ( ): = [ ] --(2)

Mathematical Model
In our model, the number of properties ( ) is a function of three variables: 1. Urban population growth rate ( ) which is a sum of natural rate of increase in population plus the net migration rate. 2. Level of public capital including physical infrastructure for sustaining basic urban lifestyle ( ). 3. Net capital inflows ( ) into the country which includes remittances and foreign direct investment in production sector. It may include foreign aid as well but it excludes foreign portfolio investment for our model. = ( , , ) --(3)

Mathematical Model

Assuming a simple Cobb-Douglas functional form for , we have: = --(4)

We can represent ( ) as a function of ( ) and governance ( ): = --(5)

Mathematical Model

If we put (4) and (5) in (2), we get: = [ ] = = 1+

Finally, assuming a Laffer curve relation between and , we put in place of where <1 for diminishing marginal contribution in taxes of increase in . = 1+ --(6)

Mathematical Model
In our model, > 0 and hence 1 + > 1 and hence we have increasing returns in taxes with additional investment in public infrastructure . In our model, > 0 and has no upper bound as it is possible to have a value greater than 1 for especially in developing countries with high rates of growth. Lastly, we assume that will also be positively related to and hence also with amount of that can be collected in the economy. Hence greater the value of , and and base values of and , greater will be the value of and hence a circular complimentary process will lead to increase in both and leading to more accumulation of and subsequent increase in in an iterative process.

Possible Hindrances in TIF Application

Low Rate of Savings

It is hard to attract investment funds in a country with very low rate of savings.

Source: Handbook of Statistics on Pakistan Economy

Possible Hindrances in TIF Application

Tax Haven for Elite Class

Lowest

Tax to GDP Ratio among IMF Classification of Middle Income Countries. Only 2% population are registered taxpayers.
Tax to GDP (%)
30 25 20 15 10 5 0 India Pakistan Sri Sub World Lanka Saharan Africa Tax to GDP (%) Source: Ministry of Finance Source: IMF High Middle Income Income

Possible Hindrances in TIF Application

Fiscal Deficit Eats Up Development Funds

Source: Ministry of Finance

Possible Hindrances in TIF Application

Lack of Documentation
Large

Informal Economy. Benaam Zameen. Flawed Documentation with False Valuation. Capitalistic Democracy Provides Status Quo Incentives

Possible Hindrances in TIF Application

Lack of Investor Confidence in Public Policies.

Policy

Reversals Case in Point: Engro Case in Point: Uncertainty in Energy Distribution

Possible Hindrances in TIF Application

Inefficiency in Public Sector

Lack

of Trust Poor Delivery & Service Record Corruption & Governance Failures DFIs Prefer NGOs Over Government

Possible Hindrances in TIF Application

Lack of Political Will

Capitalistic

Democracy Provides Status Quo

Incentives

Pre-requisites for TIF in Pakistan

Engage Remitters & Big Investors for Seed Capital

Remittances

Increased After 9/11

Went in Stock Market & Real Estate Mostly 30.00% Potential: People Prefer Real Estate Investments After Market 25.00% Crash 20.00%
15.00% 10.00% 5.00% 0.00% -5.00% -10.00% -15.00% Growth in HS Growth in Construction Remittances Growth FY06 FY07 FY08 FY09 FY10 FY11 FY12

Source: Economic Survey of Pakistan 2012-13

Pre-requisites for TIF in Pakistan

Engage Banking Liquidity for Initial Funding.

Banks

Prefer T-Bill Investments Over Private Lending Islamic Banks Have ADR ADR of 35% Only.
0.90 0.80 0.70 0.60 0.50 0.40 0.30 0.20 0.10 0.00

ADR

Source: Islamic Banking Bulletin, SBP, Various Issues

Pre-requisites for TIF in Pakistan

Connect TIF with Tax Amnesty. Connect TIF with REITs. Compliment TIF with Energy Financing.

Welfare benefits of TIF in Pakistan

Reduce urban congestion Reduce urban crimes Reduce prices of real estate Widen the urban centers Generate employment in new urban centers Facilitate closer migration to wide choice of urban centers Create new growth nodes and production zones. Reduce ethnical conflicts that arise from ethnical diversity in congested urban centers.

Thank You

For Feedback & Queries

Salman Ahmed Shaikh IBA City Campus, Garden Kiyani Road, Karachi, Pakistan Ph# 0334 3193395 Email: salmanashaikh@iba.edu.pk Web: www.islamiceconomicsproject.wordpress.com